Orlando's Outlook: Imports & inventories mask strong GDP

01-26-2018

Bottom lineGDP grew by a surprisingly weaker-than-expected annualized pace of 2.6% in the fourth quarter of 2017 versus the third quarter’s 3.2%. The Commerce Department’s flash report this morning showed that its strength was paced by strong consumer spending, housing, government spending and capital investment in nonresidential structures. But an inexplicable decline in inventories and a massively unexpected surge in imports collectively cut GDP in half.

In fact, the report's underlying strengths—mainly a strong gain in final sales to domestic purchasers—combined with the extraordinary GDP subtractions in the volatile categories of inventory restocking and imports has us expecting either an upward revision or a sharp snapback in early 2018. So, to reflect our sentiments, we are increasing our first-quarter 2018 GDP estimate from 3% to 4.5%, which increases our full-year 2018 estimate from 3.2% to 3.4% versus 2.3% in 2017.

Below consensus results The Blue Chip consensus estimate for the fourth quarter was at 2.7%, the Bloomberg consensus was at 3%, we had a 3.2% estimate here at Federated and the Atlanta Fed’s widely-followed “GDPNow” estimate was at 3.4%.

Final sales tells the tale The real story here, in our view, is that domestic final sales (GDP minus the extremely volatile net trade and inventory categories) grew at 4.3% in the fourth quarter on a quarter-over-quarter basis. That represents the fastest growth in domestic demand since the third quarter of 2014, versus 1.9% in the third quarter of 2017, and is a far cry from this morning’s disappointing 2.6% fourth-quarter flash print. So either the fourth quarter will be subsequently revised higher, or we’re likely to see a sharp snapback in the early stages of calendar 2018.

Consumer spending strong Sparked by the strongest Christmas retail season in six years, personal consumption expenditures (which account for 70% of GDP) rose by a better-than-expected 3.8% in the fourth quarter versus 2.2% growth in the third quarter. Today’s gain added 2.58 percentage points to overall fourth-quarter GDP growth.

Inventory accumulation slumps Inventories grew only modestly in the fourth quarter by $9.2 billion, down sharply from the $38.5 billion that was added in the third quarter. That subtracted 0.67 percentage points from GDP growth. Business had added $1.2 billion to inventories in the first quarter of 2017 and $5.5 billion in the second quarter, so it appeared that the restocking cycle was starting to accelerate against the backdrop of accelerating economic growth.

Massive net trade drag The dollar has lost nearly 22% of its value versus the euro over the past year. In conjunction with solid overseas demand, we expected strong exports this morning, which rose 6.9% in the fourth quarter versus 2.1% in the third quarter, adding 0.82 percentage points to GDP growth. But imports inexplicably soared 13.9% in the fourth quarter versus an outright decline of 0.7% in the third quarter, subtracting a whopping 1.96 percentage points from fourth-quarter GDP. This represents a fertile category for either revision or snapback. So net exports declined by $652.6 billion, subtracting 1.13 percentage points from GDP.

Housing rebound Against the backdrop of a year-end surge in activity, housing rose for the first time in three quarters, increasing 11.6% in the fourth quarter versus a decline of 4.7% in the third quarter. That added 0.42 percentage points to GDP.

Government spending rises Total government spending, which accounts for about 17% of U.S. GDP, rose 3.0% in the fourth quarter versus a 0.7% third-quarter increase, adding 0.50 percentage points to GDP. Federal government spending, largely paced by a 6% increase in national defense spending, added 0.23 percentage points to economic growth, while state and local spending added 0.28 percentage points.

Business fixed investment rises Nonresidential real business fixed investment rose for the seventh consecutive quarter by 6.8% in the fourth quarter versus a 4.7% gain in the third quarter, which added 0.84 percentage points to GDP. Looking at the key subcomponents, business equipment and software rose for the fifth consecutive quarter, gaining 11.4% in the fourth quarter of 2017 and adding 0.62 percentage points to GDP.